Mortgage seekers often have questions about HECM vs HELOC differences. Which one is better? Which one to choose?
In this guide, we’ll look at how HECMs and HELOCs compare. We’ll also help you decide which option is best for your situation.
Let’s get down to it.
What Is HELOC?
HELOC stands for a home equity line of credit. A HELOC is a type of loan that allows you to borrow against the equity in your home.
The loan is given in the form of a line of credit, which means you can borrow up to a certain amount and make monthly payments on the balance. The interest rate on a HELOC is typically variable, which can go up or down over time.
What Is HECM?
HECM allows you to convert your home’s equity into cash. With it, you don’t have to make monthly payments, and you don’t have to repay the loan until you sell or move out of your home.
HELOC vs HECM: the Main Differences
44% of Americans have a mortgage. If you’re one of them, you might wonder whether a HELOC or HECM is right for you.
Here’s a quick rundown of the main differences between HELOCs and HECMs:
|Annual Fee to keep the loan open
|Until sale or passing
|Usually ten years
So, what is the difference between a HELOC and HECM? As you can see, HECMs have no monthly mortgage payments, while HELOCs require monthly payments.
HECMs are only available to seniors (62+) with lower incomes and credit scores, while HELOCs are available to all homeowners regardless of age.
Now, let’s get into more detail.
To qualify for a HELOC, you need to have good credit and a loan-to-value (LTV) ratio. This means you need enough equity in your home to make a mortgage payment, i.e. the amount you owe on your house must be less than the value of your property.
Generally, you may borrow up to 85% of the value of your home, minus what you owe. A lender will also consider your credit score history, employment history, monthly income, and debts.
On the other hand, HECMs have more flexible qualifications, as they are insured by the Federal Housing Administration (FHA). This means that HECMs are available to seniors (62+) with lower incomes and credit scores.
So, which is better, HECM or HELOC? A HECM may be a good option if you want to supplement your retirement income or if you need money for unforeseen expenses.
In comparison to HELOC loans, HECM reverse mortgages are notable for their lack of monthly payments.
Moreover, if the borrower continues to live in the house as their primary residence and is current with maintenance expenses, insurance, and property taxes, they can postpone the payments until they sell their house or when the last living borrower passes away.
On top of that, if the borrowers are ready and able to pre-pay the loan, they will pay no penalties.
A HELOC has more stringent payment requirements. The first is that the borrower must make monthly interest-only payments. As a result, unless the borrower purposefully makes additional payments, the debt will not be paid down throughout the loan’s term.
There is also a prepayment penalty.
When it comes to interest rates, HELOC rates are not fixed. However, banks may limit your rates or give you a fixed rate for a set length of time.
Draw Periods and Repayment Terms
HELOCs usually have a draw period of five to ten years, during which you can borrow against your equity. After the draw period ends, you will need to repay the loan, typically over a period of 20 years.
HECMs also have a draw period, but with this type of loan, you only make interest payments during this time. The full loan amount is due when the last borrower leaves home or passes.
Line of Credit
A HECM gives the homeowner greater borrowing power. Namely, HECM borrowers do not pay an annual fee and can withdraw funds from their line of credit as often as they want as long as they continue to fulfill their obligations under the program.
How does a HECM line of credit work? If a HECM borrower maintains their home obligations, the unused line of credit will grow in value over time with no risk of being cut off or frozen.
On the other hand, if HELOC borrowers want to withdraw their money over a period of 5–10 years, they must pay an annual charge.
Moreover, a HELOC is not a good long-term safety net because they are notorious for issuing loans that are suddenly reduced, frozen, or closed with little notice to the borrower.
I.e., if a “triggering event” occurs, such as a substantial drop in the value of your house or a job loss, your HELOC account may be frozen by banks.
So, in this HELOC vs HECM battle, the latter takes the lead.
Who Should Use HELOC, and Who Should Use HECM?
HELOCs are best for those who:
- Need to access equity quickly
- Have a clear financial plan and only need to borrow a specific amount of money.
HECMs are better suited for
- Senior borrowers who are house-rich but cash-poor and intend to stay in their homes for the long haul
- Homeowners who want to use their home equity without having to make monthly payments
There is no winner in this HELOC vs reverse mortgage showdown. Ultimately, choosing the best mortgage option will depend on your unique financial situation.
So, which is the right choice for you — a HECM or HELOC? The answer to that question will depend on your financial status and goals. Both options have their pros and cons, so be sure to do your research before making a final decision.
At the end of the day, choose the option that will give you the best chance of achieving your retirement dreams.
Is a HECM the same as a reverse mortgage?
No, a HECM is not the same as a reverse mortgage. Although all HECMs are reverse mortgages, we can’t say that all reverse mortgages are HECMs. There are several types of reverse mortgages, but a HECM is the most common one.
What is the downside of a HECM?
The main downside of a HECM is that it can get expensive with all the fees. For example, the initial mortgage insurance premium for a HECM is 2% of the loan amount. You must also pay an annual mortgage premium of 0.5 percent.
You’ll also be charged an origination fee of $2,500 or 2% of the first $200,000 of your property’s value (whichever is greater), as well as 1% of the amount over $200,000.
Can you get a home equity loan with a reverse mortgage?
You cannot get a home equity loan with a HECM, but you can get a reverse mortgage and then take out a home equity loan against the equity in your home.
Is a HELOC a reverse mortgage?
No, a HELOC is not a reverse mortgage. A reverse mortgage is a loan that allows you to cash in on your home equity without having to make any payments until the loan is due (usually when you sell your home or die).
Which one to choose, HECM or HELOC?
In short, if you’re comfortable with paying monthly, typically with low-interest rates, then a HELOC may be a good choice for you.
On the other hand, if you’re a senior and don’t want the responsibility of monthly payments, then a HECM is definitely a better choice.
Talk to a financial advisor or loan officer if you’re not sure which mortgage is right for you. They can help you compare HECM vs HELOC differences and help you make the best decision based on your unique situation.